Legacy Wealth Weekly - May 20, 2016 (Not So Fast, Says the Fed!)

Penni Johnston-gill - May 20, 2016

The S&P/TSX and the S&P 500 are up slightly this week. Through the week, investors’ uneasiness stemmed from hawkish FOMC’s Minutes and a cohort of Fed members that went out and reset expectations for a June Fed hike. US 2-year bond yields have gained

Weekly Market Wrap-Up: Not So Fast, Says the Fed!

The S&P/TSX and the S&P 500 are up slightly this week. Through the week, investors’ uneasiness stemmed from hawkish FOMC’s Minutes and a cohort of Fed members that went out and reset expectations for a June Fed hike. US 2-year bond yields have gained 13bps, the biggest weekly gain since November 2015. As a result, Fed Fund futures-based probabilities of a Fed hike are the following; June (30%), July (55%), September (63%) and December (79%). The US$ (DXY) climbed for a third week in a row and cleared its 50-day moving average. It now appears that the May 3rd low on the DXY could be the low for the year, considering that, on that same day, the USD/JPY topped out at purchasing power parity (PPP) at 105. Conversely, the CDN$ likely hit its yearly peak at 80 cents (also PPP) as this week’s decoupling with oil prices suggests. Unsurprisingly, US$ strength has caused a pullback in commodities this week but the decline in commodity stocks has been very shallow. What gives?

We met with institutional clients this week in Toronto. Many investors that have played the resource rally this year worry about a replay of last summer’s relapse. However, some that have missed the advance fear that a pullback is avoided and 2016 is the resurrection of unloved resource stocks. We spent the bulk of our time discussing why odds are better this year for sustained outperformance by deep cyclical stocks. We explained that a resource cycle typically contains three phases: US$ depreciation; economic progression; and late-cycle inflation. In this cycle, we believe markets are currently doing the transition from US$ weakness to economic re-acceleration. The latter is best illustrated by our Chart of the Week. We can see that the several rate cuts seen among emerging markets (EMs) this year are now translating into economic green shoots. Indeed, the recent upticks in EM manufacturing and service PMIs are corroborated by similar upticks in industrial production and retail sales. To the extent that this progression continues, resource stocks should keep marching upward and lead commodity prices. Always remember that visibility on growth has preceded movement in commodity prices, hence the anticipatory nature of these late cyclical stocks.

Regarding economic data this week, in Canada, headline inflation leaped to 1.7% YoY (from 1.3%). The BoC core index also increased, up 2.2% YoY (from 2.1%). However, other statistics suggest underlying growth is waning. Indeed, retail sales plunged in March, down 1% for the month (-1.3% in volume terms) and settling at 3.2% YoY (from 5.7%). Meanwhile, wholesale trade declined for a second consecutive month (-1% MoM). On the bright side, we learned that foreigners bought C$6.6B of Canadian stocks, the strongest March ever. Admittedly, foreign investors have fallen in love with commodity-heavy Canadian stocks. In the US, headline inflation accelerated to 1.1% YoY (from 0.9%) but core inflation drifted slightly to 2.1% (from 2.2%). March industrial production advanced 0.7% MoM (-1.1% YoY) while housing statistics such as building permits (+3.6% MoM), housing starts (+6.6% MoM) and existing home sales (+1.7% MoM) all improved in April. Elsewhere, in China, statistics by and large missed expectations. Indeed, industrial production and retail sales slowed to 6% YoY (from 6.8%) and 10.1% YoY (from 10.5%) respectively. However, upbeat home prices (6.2% YoY from 4.9%) confirm the positive message conveyed by the upturn in China’s real estate floor space sold.

For next week, we will focus on global flash PMI releases, the BoC interest rate decision, US durable goods orders and new home sales. Finally, we await the trade balance and inflation in Japan.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.